Getting Back into the Driver's Seat

Like other automotive suppliers, it has had to shutter plants for weeks this summer thanks to the strike at
General Motors Corp.
, Lear's second largest customer. Consequently, second-quarter earnings came in at 96 cents a share, 14 cents below what the company said they would have been if not for the strike. Third-quarter projections no doubt will have to come down as well.

And stocks of auto parts suppliers have been adrift since the surprise merger between U.S. carmaker
Chrysler
and Germany's
Daimler-Benz
was announced this spring: The Dow Jones auto parts industry group is down 4 percent to date in 1998. The specter of more such combinations in the mature global auto market means suppliers can expect downward pricing pressure as they face fewer and more powerful buyers of their goods.

Now the GM. strike is over, of course, but Lear's shares remain some 15% off their 52-week highs. Before the big merger and the strike, Lear had been handily outperforming the broader market, but now the stock is up only 3% on the year, trailing the S&P 500 Index by some ten percentage points.

Why? Mainly because investors are concerned about its planned purchase of the money-losing Delphi seating business from General Motors, and they fear that Lear may end up overpaying to keep Delphi out of the hands of its competitors.

That's not unreasonable given the consolidation going on in the auto parts business itself this year. The latest move: On Monday
Federal-Mogul Corp.
said it would buy the automotive unit of
Cooper Industries Inc.
But investors cheered the news by bidding up Federal Mogul's shares some 19% since the announcement was made.

The shares appreciated so much because Federal-Mogul got a great deal, paying only about 6.5 times the Cooper unit's annual earnings before interest, taxes, depreciation and amortization (EBITDA), much lower than the 9-10x EBITDA similar deals had commanded early in the year, says Donaldson, Lufkin & Jenrette analyst Wendy Beale Needham.

Now, some fans of Lear stock say its shares could get a similar shot in the arm if Lear buys the Delphi unit for less than the market expects. (Negotiations were stalled by the GM strike, and the two parties only now are determining a price.)

Current speculation puts the tab at anywhere from $300 million to $700 million for the Delphi seating division, which has annual revenues of about $1.2 billion. But Schroder & Co. analyst John Casesa predicts that Lear will wind up paying less than $300 million for the money-losing unit. That would come out to less than 0.3 times annual sales, a pretty big discount to similar sales this year, which have gone for about one time annual revenues.

Delphi is expected to add value to Lear in several ways. CSM Corp., a Lansing, MI-based independent auto market forecaster, estimates that Delphi will help Lear increase its North American seating market share by eight to ten percentage points to 36-38% and its European share by two points to about 22 %.

Moreover, much of Delphi's overseas business is in South America, Spain and Turkey, among the fastest growing auto markets in the world. And Delphi is an underutilized business because under GM it obviously couldn't serve GM's competitors, Casesa says. But under Lear it will, and Casesa figures that once Lear turns Delphi around in a couple of years, Delphi eventually could add about $40 million in operating earnings to Lear, which last year had operating income of $666 million.

David Klassen, a portfolio manager at Vista Capital Growth thinks Lear's acquisition track record is among the best in the business. "I have enormous respect for their ability to integrate" their acquisitions, he says.

Lear's fans also point out that the shares are selling at a nice discount to the market multiple. At Wednesday's close of 50, Lear stock changed hands at less than 13 times 1999 First Call consensus estimates of $4.01 per share. That's projected earnings growth of 20% from this year's estimate of $3.33 (though that 1998 figure will likely come down because of the GM strike). The current P/E is also lower than Lear's estimated long-term growth rate of about 16%-19%.

Much of that growth is expected to come from consolidation, as Lear supplies more and more parts to the GMs, Fords, and Daimler-Chryslers of the world, says Casesa. The big auto producers are farming out more and more of their parts business to outside suppliers who can do it more efficiently, a trend that should intensify in the years ahead.

Casesa estimates that Lear, which supplied an average of $326 of parts for every car it worked on last year, will see that increase to $388 in 1999 and to $423 per car in 2001, a 30% jump over two years. In fact, Lear has its sights set on moving beyond seating to supply the whole auto interior, which Casesa estimates is worth about $1,500 per car.

When the Delphi purchase finally goes through and investors begin to take these promising growth prospects into account, Lear's shares may no longer be relegated to the backseat.

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